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MND NewsWire features plain and simple interpretations of industry related data and events written in a manner that maintains the interest of random readers while still catering to the perspective of a housing market professional.

On
Wednesday the House Financial Services Committee held the first of a scheduled series
of hearings on the financial condition of the Federal Housing Administration
(FHA). A memo released by the Committee's
chairman Jeb Hensarling (R-TX) says that the FHA's single-family insurance fund
which insures more than $1 trillion worth of home mortgages, has a negative
economic value of $16.3 billion, according to an independent actuarial report
released in November which means that if the FHA stopped writing new business
today, it could not cover the losses anticipated on loans it has already
insured.

Hensarling opened the February 6 hearing saying that, while the recently
reported negative economic growth in the last quarter does not necessarily
indicate a trend, subpar economic growth of 1-1/2 to 2 percent is now expected
and millions of Americans lay awake at night worrying about insecure financial
futures. "Hardworking Americans
demand a healthy economy and we cannot have a healthy economy until we have a
housing finance system that is both sustainable and competitive. In its current form FHA is clearly an
impediment to such a system. " The Chairman said FHA had strayed far from its original purpose and no longer
focuses on low and moderate income Americans but rather caters to a risky
market with high loan limits and extremely low down payment requirements that
put it in direct competition with the private sector. "In addition, we know that as bad as
that is, its single family insurance fund is flat broke.

"Finally, given their high Loan-To-Value, low credit score policies and
high rates of default, it is an open question whether FHA has now morphed into
Countrywide. Arguably, the FHA has now become the nation's largest subprime
lender, all with the blessing of the Administration."

Four experts spoke to the panel, three
of which were highly critical of FHA's current practices. The hearing and Hensarling's opening
statement to it included a number of references to a report written in December
by Edward J. Pinto, Resident Fellow of the American Enterprise Institute titled
How the FHA Hurts Working Families. Pinto's appearance before the
committee was based on
that paper.

Pinto
said his study identified specific reforms to focus the FHA on responsible
lending and return it to its traditional mission of serving low and middle
income, minority, or first time buyers.

Step 1: Do not knowingly insure
a loan with a
projected claim termination rate greater than 10 percent, assuming no house price appreciation or depreciation.

Step 2: Target an
average 5 percent projected claim termination rate
with the same assumption.

Step 3: Stop guaranteeing lower-risk loans and high-dollar-balance borrowers,
as this allows for cross-subsidization of
those loans with excessive
risk. This will also let the FHA step back from
markets that can
be served by the private sector
so it can concentrate on home buyers who
truly
need help.

Step 4: Price for
risk, since not doing so deprives the borrower
of the price information
needed to understand the true risk
of the loan. Until this is done, the FHA should
disclose to the borrower his or her expected
claim rate, assuming
no house price appreciation or depreciation.

Anthony
B. Sanders, Senior Scholar, The Mercatus Center Professor
of
Real Estate and Finance, School of
Management George Mason University told the committee members that the first step towards shrinking the FHA's
footprint
is to reduce the
loan limit to $625,000 and then reduce it by another $100,000 per
year.
He quoted a George Mason study that concluded that current FHA policies
are unlikely to assist the agency in reaching its historical constituencies,
first time, minority, and low-income homebuyers, and that FHA's current market
share exceeds what is needed to serve those markets. In light of the significant decline in home
values FHA could reduce its loan limits by about 50 percent and still almost
entirely satisfy its target market.

The FHA has
the highest spread of FHA 30 mortgage rates
to
GNMA 30 year
current
coupon rate
(the rate paid to GNMA investors) of any of the
government finance entities, and considerably
above levels prior
to
2008. ""In other words, the
Federal Reserve's manic pushing of interest rates and mortgage rates
downwards
is NOT getting passed
through to borrowers as
had
been hoped.""

Basil N. Petrou,
Managing Partner of Federal Financial Analytics, Inc. presented the Committee
with a laundry list of recommendations for the agency.

Congress
should reduce the 100 percent guarantee provided by the FHA to
parallel the limited coverage of
25%
to 50% successfully used
by the Veterans Administration (VA) for the mortgages
it guarantees. This will effectively cap
the severity of
loss on FHA loans and improve their underwriting by putting
the lender at risk.

The FHA should
be targeted to borrowers based on
income, not home price.
By supporting mortgage finance for higher-income borrowers
the government supplants private capital and
creates market distortions
because of the lack of market discipline
applicable to these larger loans.

FHA policy with regard to delegating
underwriting to the
loan originator and
reviewing underwriter performance only
after
the fact should be revised so FHA shares risk with regulated, capitalized providers of private credit -risk enhancement
for mortgages
(if unaffiliated with the originator) which would conduct a second underwriting
prior to loan origination.

A strict capital requirement should
be set for the FHA single-family fund incorporated
through a new actuarial
model that accurately predicts losses
and the budgetary treatment of FHA should be changed
to reflect the
fair value analysis recommended
by
the Congressional Budget
Office
(CBO).

Putting
his recommendations for FHA in the broader framework of U.S.
mortgage-finance regulation and government intervention, Petrou said he also recommends that Congress work to
ensure that an array of
pending prudential rules
for banks (e.g., those
implementing the Basel III capital
and liquidity rules)
do not block the re-entry of private capital and prevent
constructive reform of Fannie Mae and Freddie Mac. He
also advised that the pending qualified residential mortgage (QRM) rule not set
a simple down-payment
requirement
without regard to
the use of regulated, capitalized
providers of credit-risk mitigation like private mortgage insurers.
Doing so would make it extremely difficult to securitize high-
LTV loans for first-time home-buyers and other
borrowers and these loans
will flood into the GSEs and FHA and,
once
the conservatorships are closed,
then only into the FHA.

Julia
Gordon, Director, Housing Finance and Policy, Center for American Progress
Action Fund defended FHA which she said appears to be returning to normal profitability as
it
has after playing a countercyclical role in the past."FHA's
new business is significantly less
risky and will likely perform better than any books
of
business in the agency's history
yet critics continue to attack FHA's basic business model, she said.

Gordon
rebutted part of the Pinto report in which she
said he used reported losses in the wake of the crisis to portray
FHA as a destabilizing force
while omitting the context surrounding the loss
and
the way in which FHA stabilized the U.S. housing market during the
financial crisis.

Pinto has
come up with projected losses
that far exceed those predicted by
other analysts, she said.
A major reason for this
is that he fails to take into account both the superior
performance of FHA loans vis-à-vis Private Label Securitized loans, and changes made to FHA's business meant to improve its bottom line. He fails to take into account any of the policy changes that FHA has made to improve its financial position,
and uses the 2009-1010 book as a neutral period of time in which to evaluate
FHA's lending.

Gordon said that
Pinto uses a correlation between FHA and high foreclosure rates in distressed communities as
if
to imply that the FHA
is responsible for the
rate instead of unsustainable private
subprime mortgages which she said were pushed in these communities
during the housing bubble."FHA's presence helped to stabilize the neighborhood
and was not a cause but a consequence of the neighborhood's financial distress.

Gordon
said it is important to give the changes FHA has already made time to work but
also recommended it should take additional steps to improve
its
loss mitigation efforts
and better inform homeowners of its availability and should also ask Congress
for more authority to manage its risk effectively including revised indemnification authority,
greater flexibility related
to the Compare Ratio requirement, and additional servicing transfer
authority.

FHA
Commissioner Carol Galante will testify at the next hearing on February 13
regarding the November actuarial report on FHA's finances.

Comments

"Stop guaranteeing lower-risk loans and high-dollar-balance borrowers, as this allows for cross-subsidization of those loans with excessive risk" - Could I possibly be reading that correctly? Don't take on low risk loans because it encourages lending on high risk loans?

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